PERF RMANCE 04 - The Performance Portal - Ernst & Young

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“ The true benefit of the EVA is the ease with which it can be calculated and communicated.” The economic profit is excess of NOPAT over capital costs (invested capital x WACC), and therefore represents the return the firm has to generate in order to satisfy its shareholders who have “rented” capital to the firm. In practice, the true benefit of the EVA is the ease with which it can be calculated and communicated. The process of value creation quickly and easily becomes apparent. Value drivers can be characterized by profit maximization, by the decrease in the capital invested, or by the reduction of the WACC. Using the EVA terminology, the investors’ expectations are taken into account with the Market Value Added (MVA). This approach relates to the market value minus capital: MVA = Market Value – Capital = present value of all future EVAs = ∞ EVA (1 + WACC) In this way, future EVAs are estimated. If the increase in market value is added to the business assets (BA) of a company, then we can arrive at the firm value (FV) (Faupel et al. 2010, p. 59): FV = BA + MVA The adoption by businesses of EVA will assist in the decision-making process by encouraging decision-making which is better aligned to maximizing shareholder value. One of the main benefits of EVA is greater transparency, which means shareholders have a much better understanding of the business and its interaction with external influences (which could also be viewed as external costs). In addition, EVA represents a very flexible index as it can adjust to particular requirements using specific conversions. The EVA index provides great potential for integration with not only the absolute but also the relative SVA. Although both concepts are backward looking (the conventional method of SVA always measures the SVA of the previous period instead of the current period), a clear difference exists. While the new concept of the SVA represents a dynamic process, as shown in formula (3), the EVA index does ignore periodical interdependencies. The introduction of the MVA attempts to compensate for this problem with the EVA. By incorporating the future perspective provided by the SVA, an analogue model to the MVA index could be derived. The concept of the Total Sustainable Value Added (TSVA = a company’s contribution to increased sustainability in total) could be calculated as follows: MSVA = MSV — Resources = present value of all future SVAs= ∞ SVA (1 + WACR) Where: MSVA = Market SVA = market's contribution to more sustainability WACR = weighted average cost of resources 2 By estimating all future SVAs, the increase in the MSVA is taken together with the resources a company owns (resources owned = RO) resulting in the TSVA: TSVA = RO + MSVA In this way, a method for measuring the performance of a company’s contribution to increased sustainability in total is achieved. If the SVA is adopted in addition to the EVA or the MVA, when measuring performance, companies will see increased motivation among employees and will be in a better position to facilitate a dialogue with shareholders. Realizing synergies The links between the concept of SVA, shareholder value management and EVA provide enormous potential for synergies. The concept of SVA goes well beyond the generally accepted standard tools for performance measurement, which typically consider only return on capital. It is not just the opportunity cost considerations but also the introduction of the three dimensions of corporate sustainability which make the use of SVA so unique. As a consequence, what is normally a restricted view of standard financial performance measurement, can instead be expanded. Moreover, the concept of SVA relies on the patterns of shareholder value management and on the performance measurement of financial markets. At the heart of the concept of SVA is the measurement of the size of a company’s contribution to increased sustainability and an indication of the strengths and weaknesses of corporate sustainable performance. 2 The calculation of the WACR is made analogously to the WACC, where the equity is equalized with the resources owned by the company and the debt is related to the resources loaned by the company.
Measuring corporate sustainability “ At the heart of the concept of Sustainable Value Added is the measurement of the size of a company’s contribution to increased sustainability and an indication of the strengths and weaknesses of corporate sustainable performance.” A win-win situation The aim of corporate sustainability is to satisfy the needs of both the direct and indirect stakeholders. The primary purpose of the shareholder value approach is to maximize shareholder value or wealth. Therefore, a significant win-win situation occurs when both concepts are used together. The economic dimension, previously considered, has as its goal “raising the firm’s value” which is intricately linked to the goal of maximizing shareholder value. Hence, the economic pillar of the triple bottom line approach could be described as an integral part of both the shareholder value approach and the concept of corporate sustainability. Figure 2 illustrates this hypothesis. Provided the requirements of the two other dimensions (i.e., the ecological and the social ones) are fulfilled, a maximization of one dimension (here, the economic one), when also taken together with the objective of increasing shareholder value, gives a win-win situation. The arrows on the left side depict influences which effect corporate sustainability from the outside. The “…” stand for other influencing factors such as demographic, political or climate change. Any examples of influences could be listed there, therefore, the “…” were chosen. The emphasis on looking to the future is also fostered by both approaches. Summary The TSVA could serve as an excellent model for companies looking to measure sustainability performance. In addition, due to their similarities, the practical advantages of the EVA can also be seen with the SVA approach. Improved communication, transparency and simplicity of calculation contribute to a company’s ability to implement and measure valuebased, sustainable objectives. Figure 2. Economic pillar as a connecting factor Sustainable development Macro level Corporate sustainability Micro level Technological ... Social Cultural Economic Shareholder value management Ecological Social ... ... 35
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